When will the Lithium Bubble Burst?

The past month has seen Tianqi Lithium (002466.SZ) announced a bill, at their shareholder's meeting, to sign on the agreement to purchase 23.77% of SQM, in addition to other M&A bills.

Lithium demand is not abating yet. Their purchases driven by an anticipated boom in demand for lithium-ion batteries (LiBs) used in electric vehicles (EVs) and in stationary energy storage applications, i.e. in homes, businesses and on utility grids, as well as ongoing growth in demand for battery-powered consumer electronics devices and equipment. Success of such a transaction will further consolidate Tianqi's position among the "Lithium cartel".

In addition to other Mining companies like Tianqi, Chinese and Japanese battery and automakers, such as CATL fuelled by their recent IPO, has gradually entered big time into the Lithium M/A space.

Lithium is not traded widely, or on any centralised exchange or market, however, investors have been buying up shares of lithium miners and upstream supply chain producers as proxies.

The snapping up of mines, both Brine and Hard-rock, has made lithium resources more popular and promoted the rise of lithium spot prices. In turn, the rise of lithium spot prices has increased the enthusiasm of major companies to buy more.

Bubble filters to the Stock Market

Investment adviser Matt Bohlsen highlighted in his September 2017 recap of lithium spot and contract prices. “Back then if you were an early follower of mine you could have bought Chile-based SQM for US$19.99, Freeport McMoran for US$38.16, and Albemarle for US$64.50. Now that was great buying! But don’t worry if you have not bought yet, we are still in the first stage of the EV boom with EV market share globally only at ~1%.”

Bohlsen sees plenty more in the way of gains ahead, and recent developments lend substance to the bullish outlook. The Chinese government’s new mandate that EVs make up at least 10 percent of auto manufacturers’ production in 2019 and 12 percent in 2020, with higher annual percentage targets for future years expected, triggered another spike in lithium prices. The Chinese government was preceded by similar announcements on the part of France, India and Norway, all of which have announced plans to phase out production of fossil fuel vehicles.

Clearly, Bohlsen and others investing in the shares of lithium miners, supply chain participants and the like have reaped some extraordinary gains for their prescience and risk taking. But as in any speculative frenzy it’s practically impossible to separate high spirits and emotions from calm, cool, reasoned consideration of facts and data, and what we can, and can’t, conclude from them.

Is their bullish fervor regarding the prospect for the bullish trend in lithium share prices justified? Or will lithium-related investments turn out to be another example of a speculative boom and bust, as was the case with shares of internet stocks, real estate investment in the first decade of the new millennium?

The word Bubble means price is implausible with future

Tianqi's acquisition of SQM makes them become owners and part-owners to two of the best Lithium resource in the world, the Greenbushes mine in Australia and the Salar de Atacema in Chile. With this acquisition Tianqi has not only secured significant resources but is on foot in the door to wholly acquire SQM, like we know Chinese companies can do.

If the future is Electric Vehicles, then prices now doesn't seem anywhere close to instrinsic value, a precusor for a proper asset bubble. But there is a the risk of a prolonged false start.

“A false start in the EV world about a decade ago and a few high profile lithium project failures led to a long period of limited investment that ultimately has resulted in a tight market that could last a decade,” Mining veteran Joe Lowry said in an interview. “The industry was not adequately prepared for the growth profile of the electrification of transportation that we are beginning to see unfold. In fact, it is my opinion that delayed investment makes it virtually impossible for much greater than 5 percent EV penetration by 2025. I’m talking about pure EVs, not hybrids. The industry needs over $6 billion of resource investment before 2021 (~ 400,000 metric tons of new LCE capacity in chemical form) just to cover the base market, consumer battery market, ESS and 5% EV penetration in 2025.”

In addition to battery enterprises, automakers and downstream industrial enterprises are also seeking a way in the upstream Lithium supply segment so as to be self-reliant in manufacturing.

For example, Toyota (NYSE:TM) announced through its subsidiary Toyota Tsusho in February 2018 that it will buy a 15% stake into Australian miner Orocobre Ltd.

The capital injected by Toyota Tsusho will be used primarily for the expansion of the Olaroz Project (Phase 2), which targets 25,000 tonnes per annum (LCE) of additional capacity. The expansion will potentially bring the total nameplate capacity of the Olaroz Project to 42,500 tonnes per annum. There is a Stage 2 expansion decision planned for mid-2018, expected to go through once financing, approvals and engineering are completed, with commissioning in 2H 2019. As a key part of this strategic investment, Toyota Tsusho will be appointed as the exclusive sales agent for Phase 2 production and will secure a long term stable supply of lithium products to respond to the growing market demand. Toyota Tsusho will accelerate not only the expansion of the Olaroz Project via development of Phase 2, but also develop the value chain via joint investment in a Lithium Hydroxide project in Japan.

Great Wall Motor Company (601633.SH/02333.HK) also announced last year that it would invest AUD 28 million to subscribe for a 3.5% stake in Australia's Pilbara Minerals; Pilbara Minerals has a Pilgangoora Lithium Tantalum mine in Western Australia.

BYD (002594.SZ/01211.HK) has also entered the upstream sector through the acquisition of Qinghai Salt Lake (000792.SZ). BYD and Shenzhen Zhuo Yu Cheng Investment Co Ltd co-invested in Qinghai Salt Lake under a new JV called BYD Resources Development Co Ltd. BYD holds 49%.

In fact, Lu Xiangyang, one of the founders of BYD, under his investment company Rongjie Lithium, has ventured into Lithium resource and Battery technology much earlier. Together with Wang Chuanfu, the two of them started BYD in 1995, beginning Electric Vehicles research and development in 2008. However they have grappled with increasing competition and haven't been successful with securing raw material supplies and mastered the application of core technology. Rongjie Lithium holds a stake in one of the largest lithium mine in Asia - the Mika Limestone Project, through its majority owned subsidary Rongda Lithium, who controls the development and operation rights of the project.

Market Expectations

Analysts at UBS Securities expect lithium prices will remain well above historical levels through 2024 as EV batteries reach cost parity with internal combustion engines (ICE) around the middle of 2018. That will spark a huge surge in lithium demand, one lithium miners and supply chain partners will find very difficult to meet, Keith Schaefer reported in a June 17, 2017 for the Oil & Gas Investments Bulletin.

UBS analysts point out that lithium production, whether from brine or hard rock mining, will need to increase 2,898 percent in a scenario in which all the cars sold worldwide are EVs. A lot of uncertainty surrounds the question of whether or not lithium miners, refiners and distributors will be capable of meeting this level of demand.

Their record to date is spotty when it comes consistently producing lithium and at full, nameplate capacity, UBS notes.

Laurentian Capital takes a contrarian view, offering up three good reasons why soaring lithium and company shares profiting from the investment boom are set up for “The Lithium Big Short” along with one recommendation:

There are plenty of lithium reserves to satisfy the demand for many years.

The current production capacity ramp-up scramble is driven by fear of missing the price spike and greed for sharing a bigger slice of the incredible growth of demand.

There may be a huge excess of production capacity in 2018-2019, which may cause a recession in the lithium mining space following the pricking of the lithium bubble.

Prudent investors should, on the one hand, apply caution as to the junior lithium explorers and, on the other hand, be prepared to take advantage of opportunities offered by such a recession.

Investors riding the growing wave of investment in lithium production are in risky, highly speculative waters. There’s no shortage of cautionary tales whereby a huge surge of corporate investment in ramping up production in capital-intensive industries leads to spectacular business and market failures, as well as equally spectacular returns. One need only look to the internet boom of the late 1990s, or the more recent speculative surge in the share prices of solar energy companies for examples.